Question

Suppose that two competing firms, A and B, produce a homogeneous good. Both firms have a marginal cost of MC = \(50. Describe what would happen to output and price in each of the following situations if the firms are at (i) Cournot equilibrium, (ii) collusive equilibrium, and (iii) Bertrand equilibrium.

1. Because Firm A must increase wages, its MC increases to \)80.

2. The marginal cost of both firms increases.

3. The demand curve shifts to the right.

Short answer

1. The market output will reduce, and the price will increase in Cournot equilibrium. In Collusive equilibrium, the market output and price will remain the same. In Bertrand equilibrium, the market output will fall, and the market price will increase.

2. The market output will reduce, and the price will increase in Cournot equilibrium. In Collusive equilibrium, the market output will fall, and the price will increase. In Bertrand equilibrium, the market output will fall, and the market price will increase.

3. The market output will increase, and the price will rise in Cournot equilibrium. In Collusive equilibrium, the market output will increase, and the price will increase. In Bertrand equilibrium, the market output will increase, and the market price will not change.

Step-by-step solution

Step 1. Explanation for part (a)

In Cournot equilibrium, the reaction curve of firm 1 will shift inward; thus, the output will fall, and firm B will produce more, taking some share of firm A. Thus, the total market output will fall, and the price in the market will increase.

In Collusive equilibrium, as the marginal cost of firm A increases, firm A will produce zero, and all the output will produce by firm B; hence, there will be no change in market output and price.

In Bertrand equilibrium, the price is equal to price; thus, firm A price will increase, and firm B will sell at a price lower than firm A; thus, taking all the output of firm A. Hence, with the price rise, market output falls.

Step 2. Explanation for part (b)

In Cournot equilibrium, after the increase in marginal cost, the firm's output will fall; thus, total output will fall, and the market price will increase.

In Collusive equilibrium, the market output will fall, and the price will increase as the marginal cost increases.

In Bertrand equilibrium, as the marginal cost increases, the price increases; thus, the output will fall.

Step 3. Explanation for part (c)

After the rightward shift in the demand curve, the output produced by both firms will increase; thus, the total output will increase, and the price increases in Cournot equilibrium.

In Collusive equilibrium, the marginal revenue increases with demand; thus, both output and price will also increase.

In Bertrand equilibrium, the rise in demand will increase total output, but the marginal cost does not change; thus, the market price will not change.